Portugal Sells Bonds at a High Price

Portugal’s Treasury and Government Debt Agency sold the maximum intended €1 billion of a two-year government bond Wednesday but the auction came at a high price and did little to reduce expectations that the country will end up asking for a bailout.

The €750 million to €1 billion auction of the 5.45% September 2013 bond was one of the most closely watched bond auctions in the euro zone for weeks because of the attention being paid to Portugal’s funding costs.

The average yield of 5.993% was below secondary market levels–the bond traded above 6% in the run-up to the auction–but was sharply above the 4.086% level set at the previous auction, indicating how the market’s assessment of Portugal has changed for the worse in the past half-year.

While Portugal still has access to bond markets, paying a yield of around 6% for 2.5-year loans “does not look very sustainable in the long run,” said Jan von Gerich, a senior analyst at Nordea in Helsinki. “The chances that Portugal would make it on its own look slim, and a request for help from the European Union and the International Monetary Fund still looks inevitable, possibly in connection with the EU summit on March 24-25.”

After widening heavily in early trading, yield spreads on two-year Portuguese bonds over Germany tightened back after the auction, to trade 0.08 percentage point tighter on the day at 4.366 percentage points.

The 7.655% yield on the benchmark five-year Portuguese bond is now above the 10-year bond, which trades at 7.592%.

Orlando Green, a strategist at Credit Agricole, said there is a danger of a further inversion of the yield curve between the five-year and 10-year maturities. “This reflects near-term risks, with potential for the market being disappointed by the possible lack of concrete measures at the EU summit later in the month,” he said.

The auctions took place amid nervous trading conditions in sovereign bond markets ahead of an extraordinary summit of euro-zone leaders March 11.

Further bond supply this week from the euro zone’s peripheral issuers–countries with a weaker fiscal position and/or lower credit rating–added to the pressure. Spain sold €4 billion of a 15-year bond via a syndicated issue Tuesday, while Italy will auction up to €5 billion of treasury bonds Friday.

Despite the widespread expectation that Portugal will need support, Wednesday’s bond auction was expected to go well “optically,” with a decent bid-to-cover ratio, ING Bank strategist Padhraic Garvey said. But it is worrying that “investors are still very much watching events from the sidelines,” he added.

Last week, after a meeting with German Chancellor Angela Merkel, Portugal’s Prime Minister Jose Socrates insisted once again that Portugal will not need outside help, but market watchers have increasing doubts whether the country can avoid requesting help from the IMF and the EU.

“The recent economic performance hasn’t been sufficiently convincing and we expect that Portugal will need help soon,” said Frank Oland Hansen, a senior economist at Danske Bank in Copenhagen, adding that an EU/IMF credit facility for Portugal is “likely to resemble the facility for Ireland.”

In a separate reverse auction earlier in the day, the agency bought back a total of €14 million of government bonds maturing in June, and no amount of a bond maturing in April. This was Portugal’s third buyback operation since Feb. 16, bringing the total of amount of bonds bought back to €339 million.

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